Eight smart trades if China goes bust

French bank Société Générale outlined Tuesday what it said was an unlikely but not out-of-the-question scenario of a disastrous “hard landing” in China.

While not its base case (SocGen thinks China’s economy will grow 7.3% this year), the bank said it was concerned global investors were too complacent about everything working out smoothly for the Chinese economy. Its own survey found that most respondents thought the “worst reasonable case” for Chinese growth this year was a slowdown to growth of between 5.5% and 7%.

However, there are concerns that things could go wrong.

The Chinese economy needs to grow at a minimum 6% a year to keep the job market stable and ward off a systemic financial risk, according to SocGen economist Wei Yao in Hong Kong.

Maintaining that level of growth, however, is looking increasingly difficult. Yao, sees a “non-negligible” risk of a hard landing this year, noting that if investment rates simply stay unchanged, China’s growth rate will automatically cool to 4%.

Even a drop to as low as 3% growth looks likely when the effects of waning confidence are factored in. Only 5% of investors surveyed thought China’s growth would cool to less than 3.5% this year. And if those 5% are right, then here are some trades to consider:

Trade No. 1: Sell base metals and other commodities
Prices for base metals such as copper are likely to fall by as much as 50% in a worst-case scenario, while Brent crude oil would fall 30% to about $75 a barrel, according to SocGen’s Michael Haigh. He said there would be negative implications for all commodities, as China accounts for about 40% of global base-metal consumption, 23% of major agricultural crops, and 20% of non-renewable resources.

Trade No. 2: Be nimble with gold
Gauging gold’s reaction to a China bust is complicated because there’s no real way to be sure how demand will be impacted. Most likely, prices would initially rally 15% but then drop sharply amid widespread risk aversion, a repeat of the pattern seen in the 2008–2009 global financial crisis, according to SocGen.

Trade No. 3: Buy the U.S. dollar against Asian peers
During a severe economic downturn that ripped across Southeast Asia in the late 1990s, the U.S. dollar rallied around 12% against the Japanese yen, while the Australian dollar tanked 36%, and New Zealand’s currency was pummeled for a 41% loss. Expect much the same to happen this time around if China tumbles. SocGen notes that many Asian governments have been unhappy about the recent strength in their currencies and would be glad to see some weakening. That means the central banks of those nations are unlikely to step in to halt anything short of a disorderly drop in their currency’s value, the researchers said.

Trade No. 4: Bet on China devaluing the yuan
China’s central bank would likely reset its currency at a weaker level to the U.S. dollar. SocGen says the action to fix the currency at a new exchange level would follow an initial period of sharp depreciation and be part of efforts to stem capital outflows. Other emerging Asian economies are likely to see their currencies depreciate by about 10% against the dollar.

Trade No. 5: Dump China stocks
In a hard landing, Chinese stocks listed in Hong Kong are likely to drop 50% from current levels, SocGen’s researchers said. They acknowledged that the size of the decline might seem “frighteningly large” but added that the scale of swoon also was supported by historical price action during prior market routs. A halving of the stocks that comprise the Hang Seng China Enterprises Index would represent a 72% drop from the highs seen during 2008, or in line with the 79% peak-to-trough drop seen during the bear market that lasted between 1993 and 1998.

Trade No. 6: Think globally (and not in a good way) when it comes to currencies
China’s economic boom has had a broad impact across the globe, fueling development in faraway places for one reason or another. SocGen said that what had been a warm glow will transform into a chill for the currencies of commodity-rich Chile, South Africa and Russia. It’s also bad news for China’s biggest neighbors, India and Indonesia — countries with currencies SocGen described as “high-beta.” Other nations’ currencies which have benefitted from the risk-on trade also look vulnerable, according to SocGen, including the Turkish lira, Hungarian forint and Polish zloty as at risk.

Trade No. 7: Buy U.S. Treasurys
Even if the worst happens, don’t expect China to sell its U.S.-dollar-denominated assets anytime soon. Any move to exit its massive holdings of Treasurys and repatriate the funds to China would put upward pressure on China’s currency and undermine its exporters. More likely, China’s central bank would print money to support a faltering economy. In addition, U.S.-dollar-denominated assets would also be beneficiaries of capital outflows from Asia and global emerging markets, SocGen said.

Trade No. 8: Buy both guns and butter
When it comes to equities, there are few safe places, so try to pick sectors relatively protected from slower global growth. In terms of European stocks, SocGen says utilities, media and food retailers are among the best bets. Avoid mining companies, technology, personal goods and companies leveraged to global infrastructure projects, such as engineering companies.

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